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Heuristic portfolio trading rules with capital gain taxes

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  • Fischer, Marcel
  • Gallmeyer, Michael F.

Abstract

We study the out-of-sample performance of portfolio trading strategies used when an investor faces capital gain taxation and proportional transaction costs. Overlaying simple tax trading heuristics on trading strategies improves out-of-sample performance. For medium to large transaction costs, no trading strategy can outperform a 1/N trading strategy augmented with a tax heuristic, not even the most tax and transaction cost-efficient buy-and-hold strategy. Overall, the best strategy is 1/N augmented with a heuristic that allows for a fixed deviation in absolute portfolio weights. Our results thus show that the best trading strategies balance diversification considerations and tax considerations.

Suggested Citation

  • Fischer, Marcel & Gallmeyer, Michael F., 2016. "Heuristic portfolio trading rules with capital gain taxes," Journal of Financial Economics, Elsevier, vol. 119(3), pages 611-625.
    • Handle: RePEc:eee:jfinec:v:119:y:2016:i:3:p:611-625
    DOI: 10.1016/j.jfineco.2016.01.024
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    More about this item

    Keywords

    Portfolio choice; Capital gain taxation; Limited use of capital losses; Heuristic trading rules;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General

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